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Wednesday, April 20, 2005

Don't Try to "Fix" the U.S. Trade Deficit

The U.S. trade deficit has ballooned from about $100 billion ($400 per person) annually in the mid-1990s to $617 billion ($2,000 per person) in 2004, reaching an all-time monthly high of $61 billion in February 2005. Many people comment that the ever-expanding U.S. trade deficit is a danger sign of the "hollowing out" of the U.S. economy, with manufacturing and service sector jobs being outsourced to China and India. Driving the process are complacent American consumers on their usual spending spree, refinancing their home mortgages (ultimately financed by Chinese investing in U.S. bonds, we are told) to pull out cash to shop at Wal-Mart (which buys at rock-bottom prices from manufacturers in China). Even Warren Buffett goes on record in his Berkshire Hathaway annual report, stating how foreign-made products flowing into the hands of U.S. consumers are balanced by a similar amount of U.S. assets flowing out into the control of foreigners. As Buffett sees it, without a government policy change, the longer-term implication would be the transition of America into a "sharecropper's society," with Americans effectively paying rent (to foreigners) in order to live on land that was once their own--a far from happy situation for ownership-oriented Americans, which "would undoubtedly produce significant political unrest."

Expressed this way, the trade deficit seems problematical. However, I question the above viewpoint, opting instead to take a more global, "border-free" perspective. Let me explain by starting with a domestic analogy:

Consider the relationship between California, with its fertile central valley, and Washington state, with its colder climate. I'll simplify the discussion by assuming that Washingtonians, with their riches obtained from owning Microsoft stock over the past two decades, buy all of their fruits and vegetables from Californians, who are able to grow produce at a much lower cost. To feed its troops of software engineers and their families, Washington state runs a large interstate trade deficit with California, exacerbated by the preference California residents have for open-source Linux products (i.e., little interest in buying the software that Washingtonians write). Californians use their profits from thriving farm produce sales to buy, among other assets, Microsoft stock and Washington real estate. As the years go by, certain Washingtonians begin to voice concern over the interstate trade deficit, saying that dividend and rent payments are now disproportionately escaping into the hands of out-of-staters, turning Washington into a "sharecropper's state," which undoubtedly will lead to political unrest . . . . All right, with some hyperbole, I think you get the picture.

My point is that, just as no problem should or would develop between Wahington and California based on interstate trade issues, the U.S.'s international trade imbalance likewise should not be viewed as a rampant disease that needs to be cured. The existence (or non-existence) of a problem with the trade deficit really is a matter of where we draw the line between "us" and "them." At a "micro," transactional level, the American consumer who buys the goods and the manufacturer in China who runs the factory that makes them are equally happy with the business deal that is run through middlemen like Wal-Mart. Also, American consumers are pleased with the low interest rates they achieve when refinancing their homes, and the Chinese are quite content buying U.S. mortgage-backed securities. Only at the "macro" level, when we start to distinguish between "Americans" as one group and "foreigners" as another does the accounting begin to look problematical.

With American consumer behavior and the U.S. trade deficit being deep-rooted structural issues in the U.S. and world economy, I believe that appealing to the government in an attempt to "fix" what really may not be a problem at all is unnecessary and even quite risky (as the saying goes: If it ain't broken, don't fix it!). In my opinion, what concerned Americans should do is adopt a "healthier" global view, by considering both "us" Americans and "them" foreigners as all part of the same "family." Under this viewpoint, the exchange of products for assets between "younger" and "older" member nations of the same global economy would be accepted as quite normal, similar to how a retired executive sells a few shares of stock to cover his discretionary spending since the paychecks are no longer rolling in.

Of greater concern than the trade deficit itself should be the rules of the economic game. If opportunities always exist for younger people, younger generations and younger nations to grow economically by offering products (and services) to their more established "brethren" nations, what generally will result is a very natural exchange of products for assets, i.e., a trade deficit. With individuals, this basic cycle runs its course over a lifetime, whereas with nations, as history shows, the transition from "young" to "old" can take centuries. Given all of the interdependencies and linkages between nations in today's global economy, it is also possible that (again quite naturally without government intervention) trade deficits might come and go, as exchange rates, GDP growth rates, local wages and other factors all adjust to drive the complex dynamics of the global economy. (Note that the U.S. ran a trade surplus in the 1960s.)

To sum up: Trade deficits are, by and large, normal occurrences in the development of nations and evolution of the world economy. Also, the presence or absence of a trade deficit is somewhat artificial, since it depends on where we draw our national borders, i.e., how we do the accounting. Instead of prodding elected government officials to implement policy changes to balance international trade, we should spend our time encouraging our government to enforce rules to give all nations equal economic opportunity. By focussing on growing the whole economic pie rather than dwelling on the parochial "us" vs. "them" dichotomy, we will all, as global family members, be better off in the end.

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Hi Lloyd. I happened to know your blog from other blogs and your comments and thinking are very insightful to me. Thanks for blogging.

I do have some opinions on this post, though I think it might not be right since I'm only starting to invest.

I would think it is of financial prudence for any company to balance their books. Just like companies, I think countries that consistently incur budget deficits are not being prudent financially. It is true that there are "good debt" and "bad debt" and we should differentiate between these 2 to see if the borrowings that your Govt are making are good or bad. But undertaking too much debt for a company leaves it at a higher risk of bankruptcy, while you have also noted that you prefer companies with low debt levels. So I would tend to agree with Buffett's view that the U.S. Govt is giving an increasing amount of assets away to foreigners.

But I'm of the thinking that we have to promote free trade and that trade deficits do occur occasionally. But to consistently incur so much deficits in so many years just doesn't sound prudent to me.

The dollar, as predicted is being crushed. We are now at Par with the Canadian Dollar, the Loonie as it is called. This was all so predictable. You cannot run an 800 bilion dollar trade deficit and have your currency in demand. We have a lot farther to fall. Within 5 years from 2008 we should see the Canadian Dollar worth 25 % more than the U.S. dollar. The Euro at 1.40 now, should move to near 2.50, as China buys more and more of the Euro.The pound at 2.04 as I write this will be near 3.00. Be ready for CHINA. When they finally let their currency float it will appreciate 70% over a 36 month period. The US trade deficit will be cut in half and then some by 2020.

Bernanke has a big job ahead of him. We cannot sustain 800 bilion a year trade deficits. We cannot export our way out of this mess. The only answer is a sharply lower dollar to drive manufactruing home and to lower the trade deficit. The dollar has much farther to fall. What you are seeing is a long term effort (it will take 20 years) to get the trade deficit back under 1% of GDP. We are currently running a trade imbalance of nearly 6% of GDP. No nation can do this. The IMF would be stepping in to help any nation if its trade imbalance went to 6% of GDP becuase its currency would collapse! The U.S. is different, but still, we cannot sustain a trade deficit of this magnitude. People must understand that when we buy an item from say China, we pay in dollars. The Chinese company we just bought from them goes to an Exchange Bank in China and converts those dollars to Yuan. The Chinese banking system (Chinese Government) is now sitting on those dollars. They can either 1, buy oil, 2, buy Treasuries, 3. buy U.S goods, 4. buy U.S. Corporations, 5. other. Over time if we (the U.S. ) continue to run a trade deficit we could simply be completely bought and controlled by foreigners. Warren Buffet has explained the situation as being like a rich Texas farmer who loses a small piece of his land year after year and never notices for a while. When he then notices, tragedy sets in because he no longer controls his land. So in sum, we need to get the trade deficit way down. This is why the Fed has abandoned the dollar. It wil be going down for the next 20 years. That is how long it is going to take to correct this imbalance mess.

The U.S. Trade Deficit is a huge problem. We will either end up being owned by foreigners or we will simply fade away. Both prospects are quite un-American. Some basic facts: The U.S. has not had a trade surplus with the world since 1974. We have not had a trade surplus with Japan since April of 1976. We stopped having trade surpluses with Eurpoe in 1983. Fifteen years ago we did not have a trade deficit with China. Now we have a 250 Billion a year deficit with the People's Republic. A nation that does not make anything is a worthless nation. Worse, the longer we go without making the needed investments in our manufacturing infrastructure, the more knowledge we lose. We will either forget how to manufacture or we will simply not be good at it. Our creative energy fades away if we do not use it. Also, it is innate to want to make things. Kids play in sand boxes, youg men build tree forts. This is human nature. All of this is being taken away from the American people by idiots in Washington who do not know how to make trade deals. I may write a book on this topic.

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This whole notion of free trade is phoney. We are becoming a nation of financial services companies All these companies do is recycle money. The result is no useful products and services are being produced or sold. The idea that the bedrock of the united states economy can be a country of bankers financial planners financial researchers dealing with numbers marketing consultents' lawyers is completly false. I could go on and on but I need not. The intangable economy of sorts must be replaced with a economy that produces or provides useful products and services that are really needed. Otherwise we will end up with a few bright CPA's with master degrees siting behind desks making a good living and everybody else cleaning the carpeting and emptying the wast paper baskets.For three dollars an hour.